Tuesday, December 6, 2016

Weekly Market Summary

Summary: US equities have made new all-time highs in the past week. Breadth is good. But there is a set-up for price gains to be limited (or negative) in the next 1-2 weeks.

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In the past week, SPX, DJIA and RUT have all made new all-time highs (ATH). Each is within 1% of those highs today. All of their respective moving averages, from 5-d to 200-d, are rising. This is the definition of an uptrending equity market. Enlarge any chart by clicking on it.

Friday, December 2, 2016

December Macro Update: Employment Growth Is Decelerating

SummaryThe macro data from the past month continues to mostly point to positive growth. On balance, the evidence suggests the imminent onset of a recession is unlikely.

That said, there are some signs of weakness creeping into the data. Most importantly, employment growth is decelerating, from over 2% last year to 1.6% now. Housing starts and permits have flattened over the past year. There is nothing alarming in any of this but it is noteworthy that expansions weaken before they end, and these are signs of some weakening that bear monitoring closely.

Overall, the main positives from the recent data are in employment, consumption growth and housing:
  • Monthly employment gains have averaged 188,000 during the past year, with annual growth of 1.6% yoy.  Full-time employment is leading.
  • Recent compensation growth is near the highest in 7 years: 2.5% yoy in November. 
  • Most measures of demand show 3-4% nominal growth. Real personal consumption growth in October was 2.8%.  Retail sales reached a new all-time high in October, growing 2.6% yoy.
  • Housing sales are near a 9 year high. Starts made a new 9 year high in October.
  • The core inflation rate has remained near 2% since November 2015.
The main negatives are concentrated in the manufacturing sector (which accounts for less than 10% of employment):
  • Core durable goods growth rose 1.0% yoy in October. It was weak during the winter of 2015 and it has not rebounded since. 
  • Industrial production has also been weak, falling -1.0% yoy due to weakness in mining (oil and coal). The manufacturing component grew +0.1% yoy.
Prior macro posts from the past year are here.

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Our key message over the past 3 years has been that (a) growth is positive but slow, in the range of ~3-4% (nominal), and; (b) current growth is lower than in prior periods of economic expansion and a return to 1980s or 1990s style growth does not appear likely.

Modest growth should not be a surprise. This is the typical pattern in the years following a financial crisis like the one experienced in 2008-09.

This is germane to equity markets in that macro growth drives corporate revenue, profit expansion and valuation levels. The saying that "the stock market is not the economy" is true on a day to day or even month to month basis, but over time these two move together. When they diverge, it is normally a function of emotion, whether measured in valuation premiums/discounts or sentiment extremes (enlarge any image by clicking on it).

A valuable post on using macro data to improve trend following investment strategies can be found here.

Let's review each of these points in turn. We'll focus on four macro categories: labor market, inflation, end-demand and housing.

Employment and Wages

The November non-farm payroll was 178,000 new employees less 2,000 in revisions.

In the past 12 months, the average monthly gain in employment was 188,000.

Monthly NFP prints are normally volatile. Since 2004, NFP prints near 300,000 have been followed by ones near or under 100,000. That has been a pattern during every bull market; NFP was negative in 1993, 1995, 1996 and 1997. The low prints of 84,000 in March 2015 and 24,000 in May 2016 fit the historical pattern. This is normal, not unusual or unexpected.

Sunday, November 27, 2016

What Happened To The Earnings Recession?

Summary: A year ago, profits for companies in the S&P had declined 15% year over year (yoy). Sales were 3% lower. Margins had fallen more than 100 basis points. The consensus believed all of this signaled the start of a recession in the US.

How has that dire prognosis worked out? In a word: terrible. Jobless claims are at more than a 40 year low and retail sales are at an all-time high. The US economy continues to expand.

In the past year, S&P profits have grown 12% yoy. Sales are 2.4% higher. By some measures, profit margins are at new highs. Why were the critics wrong? They confused a collapse in one sector - energy, where sales dropped by 60% - with a general decline in all sectors. Energy was considered the same as financials in 2007-08; events since then show that it is nothing like financials.

Where critics have a valid point is valuation: even excluding energy, the S&P is highly valued. With economic growth of 3-4% (nominal), it will likely take exuberance among investors to propel S&P price appreciation at a significantly faster annual clip.

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A year ago, profits for companies in the S&P had declined 15% year over year (yoy). Sales were 3% lower. Margins had fallen more than 100 basis points. The consensus believed all of this signaled the start of a recession in the US.

The chart below was from Barclays at the start of the 2016, who said that big drops in profitability like those last year have coincided with a recession 5 of the last 6 times since 1973 (read further here). Enlarge any chart by clicking on it.

Wednesday, November 23, 2016

Technology, Not Trade or Regulations, Killed Manufacturing Jobs

Summary: Manufacturing output is at an all-time high. Manufacturing employment is at a post-industrialization low. Deregulation, dollar devaluation and protectionist/isolationist policies will not resurrect manufacturing employment.

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The Economist:
In the early postwar decades, the American economy grew at a healthy clip. Millions of Americans earned a middle class wage by working in manufacturing. In recent decades, rising inequality and the stagnation of middle class earnings have generated a wave of nostalgia for the postwar economy, and for manufacturing employment in particular. If only America hadn't lost its manufacturing edge, all would be well.
You might reasonably guess that manufacturing in the US is in a secular downtrend. It's not. Real output is at an all-time high (ATH). It has nearly doubled in the past 30 years.

Sunday, November 20, 2016

Forecasting The Next Recession Based On The Calendar And The Presidency

Summary: The US economy will soon be in its 8th year of expansion. The US will also have a new president next year. So, is a recession a certainty in 2017? No. Economic expansions don't die at a predetermined definition of old age, and changes in the presidency have not been a useful predictor of a coming recession. The danger in forecasting based on these things is that it makes an imminent downturn appear to be a fait accompli. It's not, and believing that it is closes your mind to other possibilities. Maintaining a mind open to changes in the data and the opportunities they present is the essence of successful investing.

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Will 2017 bring a recession? The calendar says it's likely.

The Great Recession officially ended in June 2009, 7-1/2 years ago. That is already a long time without a recession. Since 1900, the US has stayed out of a recession longer only two other times: the 1960s (9 years) and the 1990s (10 years).

There have been 23 recessions since 1900, and 21 of them have taken place within 8-1/2 years of the prior one's end. So, the historical odds based on the calendar say the next recession is likely to start in 2017 (21/23 = 91%).

Notably, the time between recessions has been expanding over time. At the turn of the 20th century, recessions took place very other year. They now take place nearly every other decade. Consider the following:
Between 1900 and 1928: a recession every 1 year and 10 months.
Between 1929 and 1949:  a recession every 3 years and 8 months.
Since 1950:  a recession every 5 years and 9 months. 
Since 1990: a recession every 8 years.